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The Sunday Times 01 October 2017


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Hope springs eternal. The optimism which drives us to buy lottery tickets, provide patronage to bookies or to anticipate little traffic on the way to Brittas, is borne out of a quintessential human characteristic to ignore the overwhelming odds against.

To this unholy trinity we may well in time add the current financial craze du-jour that is investing in cryptocurrencies.

The popularity of bitcoin, the original and most significant of the cryptocurrencies, is near fever-pitch. I’m increasingly being asked about it, no doubt influenced by the meteoric rise in its value. At the start of 2017 bitcoin was priced at just under $1,000. By the start of September the price was in touching distance of $5,000.

My response to date has been a lazy one; it’s in my too hard pile but it has all the hallmarks of a bubble. Our brains are lazy and when faced with a difficult question, frequently we resort to answering a different, simpler one.

What are the prospects for cryptocurrencies, like bitcoin, is a complex question. Though it looks to have many tulip-like qualities, dismissing it as merely a passing fad is increasingly at odds with the data we are observing. As of August 2017, the combined market value of all cryptocurrencies is $145 billion.

Bitcoin is defined as an open source peer-to-peer currency and a digital payment system. It operates without any central authority, bank or administrator, with payments processed directly between participants on an open network.

The financial services industry is not lauded for the societal value created by many of its innovations. According to some, the last useful one was the ATM some forty years ago. But cryptocurrencies are not a financial innovation per se. They are more of a technological innovation.

Herein lies much of the difficulty involved in figuring them out. The technology is complex.

Bitcoin arrived on the scene in 2009 at a time of increasing distrust in Government-backed fiat currencies.  Today there are hundreds of digital currencies– including eleven with market capitalisations over a billion dollars – and no limits on the creation of new ones. So-called initial coin offerings, or ICOs, have turned into 2017’s most remarkable financial craze. According to the Financial Times, more than $1.8bn has been raised by software developers from the sale of new currencies with names such as Tezzies and Basic Attention Tokens. My favourite cryptocurrency name is Ether, as it seems to capture much of the zeitgeist in its short title.

Part of the rationale for cryptocurrenncies is that they can’t be debased in the same way a fiat currency can (think Zimbabwean Dollar or Venezuelan bolivar) as there is a pre-determined maximum level of issuance. But even bitcoin itself has had a split. At the end of July, some of the people who wanted bitcoin to expand quickly broke off and created a rival digital currency, known as Bitcoin Cash, that can handle more frequent transactions.

The cryptocurrency enthusiasts argue that the case for buying today despite a meteoric rise in the price is, if bitcoin is accepted as a currency to rival the dollar, you could make 70 - 140 times your money. That’s a fair leap, but you can see what drives investor enthusiasm; success doesn’t have to be highly probable with such a huge expected return. 

This lottery-ticket quality is reminiscent of the dot-com boom in 1999-2000. Amazon Chief Executive Officer Jeff Bezos' recent annual letter to the company's shareholders provides a salutary tale from that era.

Appended to this year’s letter is his first such one from 1997. Here's a sentence that catches the eye: “We established long-term relationships with many important strategic partners, including America Online, Yahoo!, Excite, Netscape, GeoCities, AltaVista, @Home, and Prodigy." Twenty years on, most don't exist or are utterly irrelevant.

Bitcoin’s obituary has been written hundreds of times. I’m not going to add another. Likely the most enduring part of this phase in markets may be the blockchain and not the currencies themselves. The potential applications for it are significant but the extent to which it realises its potential will depend in substantial part upon how well stakeholders steward its development.

That doesn’t mean to say the currencies are doomed to failure. The crypto currency game is still young and the competing players each claim to have found the panacea for eventual acceptance. However as technologies and preferences evolve, there will be an inevitable thinning of the herd. This is the problem with investing in the next great thing - typically only a few firms win. As Warren Buffett once pointed out, 2,000 or so car companies operated around the time that Henry Ford started his assembly lines. Investing in the auto sector was correct. But investing in most of those companies was not. The lessons are there, but in the battle of hope and experience, the former is the usual victor.

Warning: Past performance is not a reliable guide to future performance. The value of your investment may go down as well as up. This product may be affected by changes in currency exchange rates. Forecasts are not a reliable guide to future performance.

Gary Connolly is Managing Director of iCubed. He can be contacted at gary@icubed.ie or on twitter @gconno1. iCubed Training, Research and Consulting, trading as iCubed, is regulated by the Central Bank of Ireland.

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